How the fiscal cliff affects IT

Since the election, the political news cycle has revolved around the impending "fiscal cliff," a perfect storm of tax increases and government spending cuts set to take effect on Jan. 2, 2013. Although the IT industry may not have paid much attention, it's just as susceptible to the policy changes as the rest of the economy.

The policy changes range from the removal of tax provisions for small businesses to massive cuts in spending on federal programs. The Congressional Budget Office predicts that, if these policy changes are not altered by the turn of the year, the U.S. economy could plunge back into recession in 2013, with real gross domestic product dropping by 0.5% and unemployment shooting back up to 9.1%.

Network World spoke with Lamar Whitman, director of public advocacy for CompTIA, and Richard Davis, managing director covering enterprise software for investment bank Canaccord Genuity, about the specific tax and government spending changes that could have the most significant impact on IT companies, as well as how they could protect themselves.

Sequestration will slash federal IT spending

Whitman pointed to sequestration - a combined $66 billion in spending cuts among federal programs - as the biggest threat to the overall IT industry. If enacted, the cuts would be distributed evenly across defense and non-defense programs, and the money that pays IT contractors serving federal agencies of all kinds could suddenly dry up.

"When we get to Jan. 2 and the sequestration does occur, clearly government will have to be reassessing some of its technology needs and contracts at that time," Whitman says. "We're just going to be put in a holding pattern to wait and see."

If possible, Davis advises businesses with standing contracts to extend their services engagements. This doesn't bring in additional revenue, but Davis says a move to extend a services agreement could ensure income for a longer period of time. For example, a six-month services engagement could be extended to a nine-month agreement, and although the monthly amounts would need to be reduced, the contractor is afforded a few extra months of revenue while it seeks new business.

Sequestration could, however, have a ripple effect in the private market. If the public sector market thins out, those serving it aren't going to simply fold, Whitman says.

"If you have a company that's solely involved in government contracting and therefore their business is cut off, they're going to try to branch out into other forms of business, at least in the near term, which will squeeze out other companies," he says. "So even if companies aren't directly involved in government contracting, there's going to be some squeezing out within the industry because of that void of funds."

Vendors looking to compete in a more crowded market will need to show more concrete return on investment, Davis says. Customers will also be more fiscally tight, and will therefore be less likely to invest in products that cannot prove "hard-dollar ROI," he says.

Small business expensing and bonus first-year depreciation

Previously, the "small business expensing" provision allowed small businesses to write off up to $139,000 in expenses on items that could be classified as assets. Those that exceeded that limit were afforded the "bonus first-year deprecation," which allowed 100% depreciation of the remaining amount for that same year. The intention was to provide relief so startups and small businesses could launch and grow without drowning in the initial costs.

However, as part of the tax increases, these provisions are undergoing some changes. The small business expensing provision will be reduced from its $139,000 allowance to $25,000 in 2013. On top of that, the bonus first-year depreciation was reduced to 50% in 2012, and will be dissolved completely in 2013.

Beyond the impact on internal expenses, the changes to these tax provisions could hamper sales for IT vendors whose customers were previously able to write off their purchases, Whitman says.

"This is an incentive to purchase the IT systems that may be a cost break," he says. "Otherwise, they might not have done [the purchase] after making a cost analysis of the tax costs."

Whitman added that it's possible the removal of these tax breaks could turn off potential IT customers.

Another approach private companies take in a tough economy is restructuring their pricing models, Davis says. To retain customers that may be affected by changes to tax provisions, vendors can reduce their prices or offer products or services on a subscription basis, Davis says.

"Hopefully the reason someone is buying your technology is not just for the tax break," he says. "So what you may do to make it easier is, as a vendor, make it a little bit better of a price, lower your price a bit to offset that tax break the customer is no longer getting."

While he acknowledges that this could mean smaller margins for some vendors, Davis says a drop in revenue may be inevitable for some. However, changes in pricing structure could make for a much brighter future than an outright loss of customers.

"I think what it means is it will just be a valley, not a cliff, for those companies, Davis says. "If we talk about a fiscal cliff, it might end up being a fiscal valley for a lot of the vendors."

IT training and the workforce

Sequestration could put funding for federal IT training and educational programs at risk. For an IT industry that's currently suffering from a skills gap in its workforce, Whitman says sequestration could make it more difficult for companies that are hiring to find adequate candidates.

"One of the big things was the skills gap, where there were hundreds of thousands of IT jobs open but they were not filling those IT jobs because there weren't people with the proper training," Whitman says. "I think with the sequestration and the decrease in education funding or training funding, I think that's another important aspect of the problems of sequestration for the IT industry."

Statistics from Indeed.com show more than 227,000 unfilled jobs in information technology, putting the industry third on the list behind healthcare and retail. And that figure may not accurately reflect the full economic impact of IT training on the U.S. workforce.

"For example, the health IT technician at a hospital, the graphic designer for a communications firm, or a data analyst at a financial services company all require an IT background, because their jobs are grounded in technological know-how," a 2011 CompTIA report on the IT job market reads.

At the time of the report, CompTIA estimated that IT skills account for approximately 5 million jobs in the U.S.

In addition to the public high school, community college and university IT courses funded by the government, sequestration puts programs for military service members at risk, CompTIA director of corporate communications Steven Ostrowski says. The White House estimates that more than 1 million armed forces personnel will transition out of the military by 2016, most of whom "are going to enter the workforce looking for work," Ostrowski says.

"There is a need for training upfront," he says. "You might know how to turn on a computer and send an email, but there's a lot more that goes into that before you can jump in and start working in the industry."

Colin Neagle covers emerging technologies and the startup scene for Network World. Follow him on Twitter https://twitter.com/#!/ntwrkwrldneagle and keep up with the Microsoft, Cisco and Open Source community blogs. Colin's email address is cneagle@nww.com.

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